Throughout most of the 20th century, one of the leading proponents of the gold standard was the Austrian economist Ludwig von Mises. Why gold? Mises explained this many times, but did so, perhaps, most concisely in a 1965 essay entitled “The Gold Problem”:

“Why have a monetary system based on gold? Because, as conditions are today, and for the time that can be foreseen today, the gold standard alone makes the determination of money’s purchasing power independent of the ambitions and machinations of governments, of dictators, of political parties, and of pressure groups. The gold standard alone is what the nineteenth-century freedom-loving leaders (who championed representative government, civil liberties, and prosperity for all) called ‘sound money.’ The eminence and usefulness of the gold standard consists in the fact that it makes the supply of money depend on the profitability of mining gold, and thus checks large-scale inflationary ventures on the part of governments.”

But, at the same time, Mises was conscious of the fact that even a gold standard established and controlled by the political authority was still a managed monetary system. Thus, in Monetary Stabilization and Cyclical Policy (1928), he emphasized:

“However, it should certainly not be forgotten that under the “pure” gold standard governmental measures may also have a significant influence on the formation of the value of gold. In the first place, governmental actions determine whether to adopt the gold standard, abandon it, or return to it. Every political act … insofar as it affects the demand for, and the quantity of, gold as money, represents a “manipulation” of the gold standard and affects all countries adhering to the gold standard.

“… In this sense, all monetary standards may be “manipulated” under today’s economic conditions.”

The importance of a monetary system based on gold, therefore, in Mises’s view, was that it limited the range of discretion open to governments to manipulate the quantity and value of money. The fundamental rule that the supply of money in the economy is anchored to the profitability of gold production as determined by market forces depoliticized the monetary system to a significant degree. Given an established redemption ratio between bank notes and a quantity of gold on deposit in banks; given fixed reserve requirements on checking and other forms of bank deposits; given an established rule of the right of free import and export of gold between one’s own country and the rest of the world; and assuming that the political authority with responsibility over the country’s monetary system does not interfere with these conditions and rules, then political influences on the value and quantity of money would be minimized.

But since such a gold-based monetary system would still be established by the political authority and managed and supervised by the political authority or its designated institutional agent, even a gold standard was open to state intervention and manipulation. And having this authority, Mises argued, those political agencies assigned the task of managing a country’s monetary system increasingly manipulated the gold standard in the last decades of the 19th century and early decades of the 20th century, reflecting the growing socialist, interventionist-welfare statist and Keynesian ideas that had come to dominate during that period. The protective safeguards against inflation and monetary mismanagement that even a gold standard had offered were eaten away. As Mises expressed it in The Theory of Money and Credit in 1924:

“The safeguards erected by the [classical] liberal legislation of the nineteenth century to protect the bank-of-issue [i.e., the central bank] system against abuse by the State have proved inadequate. Nothing has been easier than to treat with contempt all the legislative provisions for the protection of the monetary standard. All governments, even the weakest and most incapable, have managed it without difficulty. Their banking policies have enabled them to bring about the state of affairs that the gold standard was designed to prevent: subjection of the value of money to the influence of political forces.”

This led Mises to the conclusion that whatever shortcomings or problems that might have been seen in the idea of an unregulated, free banking system, all such criticisms paled into insignificance in comparison with the politically created monetary chaos during the First World War and ever since then. The destruction of the German mark during the great German inflation of the early 1920s was merely the starkest example, in his view. The only monetary and banking system that would have the potential capability of minimizing, if not preventing, monetary abuses on the part of governments would be a free banking system. In Human Action (1949), Mises summarized the case for a free banking system:

“What is needed to prevent any further [monetary abuse] is to place the banking business under the general rule of commercial and civil laws compelling every individual and firm to fulfill all obligations in full compliance with the terms of contract…. Free banking is the only method available for the prevention of the dangers inherent in credit expansion…. Under free banking it would have been impossible for credit expansion with all its inevitable consequences to have developed into a regular — one is tempted to say normal — feature of the economic system. Only free banking would have rendered the market economy secure against crises and depressions.”

How a free banking system would create incentives on the part of those owning and managing unregulated private banks to restrain their issuance of what Mises called “fiduciary media” (bank notes and bank deposit accounts not 100 percent fully covered by gold and other specie reserves in their banks) was concisely explained by him in Monetary Stabilization and Cyclical Policy :

“Even if governments had never concerned themselves with the issue of fiduciary media, there would still be [private] banks of issue and fiduciary media in the form of notes as well as checking accounts. There would then be no legal limitation on the issue of fiduciary media. Free banking would prevail. However, banks would have to be especially cautious because of the sensitivity to loss of reputation of their fiduciary media, which no one would be forced to accept. In the course of time, the inhabitants of capitalistic countries would learn to differentiate between good and bad banks. No government would exert pressure on the banks to discount [loans] on easier terms than the banks themselves could justify. However, the managers of solvent and highly respected banks, the only banks whose fiduciary media would enjoy the general confidence essential for money-substitute quality, would have learned from past experiences. Even if they scarcely detected the deeper correlations, they would nevertheless know how far they might go without precipitating the danger of a breakdown.

“The cautious policy of restraint on the part of respected and well-established banks would compel the more irresponsible managers of other banks to follow suit, however much they might want to discount [loans] more generously. If several [private] banks of issue, each enjoying equal rights, existed side by side, and if some of them sought to expand the volume of circulation credit [i.e., notes and deposits not backed 100 percent by gold] while the others did not alter their conduct, then at every bank clearing [i.e., the settling of accounts among the banks], demand balances would regularly appear in favor of the conservative institutions. As a result of presentation of notes for redemption and withdrawal of their cash balances, the expanding banks would very quickly be compelled once more to limit the scale of their emissions.”

Would the establishment of a truly free banking system make a country’s monetary system impervious to state control, manipulation, and destruction? Mises admitted that it might not, because ultimately a sound monetary and banking system could be maintained only against the background of an ideology consistent with the classical-liberal ideals of individual freedom, a free-market economy, and free trade. When he asked in 1924 whether a free banking system could have survived state encroachments in 1914, when World War I began and governments became hungry for revenue and wealth for the expansion of giant war machines, Mises admitted that the answer would probably have been “No.” The permanent securing of a monetary system from political abuse and control could come only from a change in the ideologies that had come to dominate men’s minds in the 20th century. In a monograph entitled Stabilization of the Monetary Unit — From the Viewpoint of Theory, published in 1923 as the great German inflation was reaching its climax of destruction, Mises argued:

“Inflationism, however, is not an isolated phenomenon. It is only one piece in the total framework of politico-economic and socio-philosophical ideas of our time. Just as the sound money policy of gold standard advocates went hand in hand with [classical] liberalism, free trade, capitalism and peace, so is inflationism part and parcel of imperialism, militarism, protectionism, statism and socialism….

“The belief that a sound money system can once again be attained without making substantial changes in economic policy is a serious error. What is needed first and foremost is to renounce all inflationist fallacies. This renunciation cannot last, however, if it is not firmly grounded on a full and complete divorce of ideology from all imperialist, militarist, protectionist, statist, and socialist ideas.”

But through the decades after Mises wrote these words in the early 1920s, governments around the world only moved further in the statist and socialist directions about which he expressed such deep concern. However, now at the end of the 20th century, as market-oriented ideas have once again become a growing force in political debates, the idea of the denationalization of money has been raised as the alternative to central banking for the first time in more than a century. And the opening of this modern debate was begun by Mises’s Austrian-school colleague, Friedrich A. Hayek, in the 1970s.

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Dr. Richard M. Ebeling is the recently appointed BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel. He was formerly professor of Economics at Northwood University, president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).

Reading List

Prepared by Richard M. Ebeling

Austrian economics is a distinctive approach to the discipline of economics that analyzes market forces without ever losing sight of the logic of individual human action. Two of the major Austrian economists in the 20th century have been Friedrich A. Hayek, who won the Nobel Prize in Economics, and Ludwig von Mises. Posted below is an Austrian Economics reading list prepared by Richard M. Ebeling, economics professor at Northwood University in Midland and former president of the Foundation for Economic Education and vice president of academic affairs at FFF.